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MODULE NO-3

Corporate governance
Corporate Governance is concerned with holding the balance between economic and social goals and

between individual and communal goals.


Corporate Governance is a relationship among

stakeholders that is used to determine and control the


strategic direction and performance of organizations

The corporate governance framework is there to encourage the efficient use of resources and

equally

to

require

accountability

for

the

stewardship of those resources. The aim is to align as nearly as possible the

interests of individuals, corporations and society


- Sir Adrian Cadbury

Corporate Governance Contd


The primary purpose of corporate leadership is to create wealth legally and ethically.
This translates to bringing a high level of satisfaction to five constituencies -- customers, employees, investors, vendors and the society-at-large. The raison d'tre (FACT IN PURPOSE) of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year. ----- N R Narayana Murthy

History of Corp Gov. in India


Unlike South-East and East Asia, the corporate governance initiative in India

was not triggered by any serious nationwide financial, banking and economic
collapse

Also, unlike most OECD countries, the initiative in India was initially driven by

an industry association, the Confederation of Indian Industry

In December 1995, CII set up a task force to design a voluntary code of corporate governance

The final draft of this code was widely circulated in 1997


In April 1998, the code was released. It was called Desirable Corporate Governance: A Code Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others

History of Corp Gov in India


Following CIIs (confederation of indian industry) initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies The Birla Committee Report was approved by SEBI in December 2000 Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan

History of Corp Gov in India


Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees

In 2001-02, certain accounting standards were modified to further improve


financial disclosures. These were: Disclosure of related party transactions Disclosure of segment income: revenues, profits and capital employed Deferred tax liabilities or assets Consolidation of accounts

Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors independence

Fundamental Objective of Corporate Governance

Enhancement of Shareholder Value, keeping in view the Interests of other Stakeholders CG a Way of Life rather than a Code

Constituents of Corp Gov.


The Board of Directors
Pivotal role Accountable to stakeholders Directs management

The Shareholders & Stakeholders


To participate in appointment of directors To hold the BoD accountable for governance through proper disclosures

The Management
To act on the direction of the BoD To provide requisite information to the BoD for decision making To implement and monitor control systems

The MARKET (outsider) model


A priority to market regulation the owners of firms tend to have a transitory interest in the firm Focusing on the reasons for the absence of close relationships between shareholders and management Highlighting the existence of an active `market for corporate control - takeovers, particularly hostile ones Indicating the primacy of shareholder rights over those of other organizational groups

The CONTROL (insider) model


The priority to organisational stakeholders control The owners of firms tend to have an enduring interest in the company They often hold positions on the board of directors or other senior managerial positions which is also known as dual role The relationships between management and shareholders are close and stable There is little by way of a market for corporate control the existence of formal rights for employees to influence key managerial decisions

(control) INSIDER
Equity market Share ownership Voting power Main shareholder Corporate control market Information Composition of BoD few listed company concentrated high concentration (pyramids, non-voting shares, multiple voting) families, banks, other companies, government

(market) OUTSIDER
wide market Dispersed low concentration, separation between ownership and control institutional investors, individual shareholders high activity in corporate control market public presence of outside directors Low

low level of takeover


private large number of directors appointed by the main block holder high

Control on Management

OECD
The Organisation for Economic Co-operation and Development (OECD; French: Organisation de coopration et de

dveloppement conomiques, OCDE) is an international economic


organisation of 34 countries founded in 1961 to stimulate economic progress and world trade. It is a forum of countries committed to democracy and the free-market economy, providing a platform to compare policy experiences, seek answers to

common problems, identify good practices, and co-ordinate


domestic & international policies of its members.

OECD

Contd.

The OECD originated in 1948 as the Organisation for European Economic Co-operation (OEEC), led by Robert Marjolin ofFrance, to

help administer the Marshall Plan (which was rejected by Soviet


Union and its satellite states) by allocating American financial aid and implementing economic programs for the reconstruction of

Europe after World War II, where similar efforts in the Economic
Cooperation Act of 1948 of USA, which stipulated the Marshall Plan that had also taken places elsewhere in the world to war-torn Republic of China and post-war Korea, but the American recovery program in Europe was the most successful one

OECD
for Economic Co-operation

Contd
and Development by

In 1961, the OEEC was reformed into the Organisation

theConvention on the Organisation for Economic Cooperation and Development and membership was

extended to non-European states. Most OECD members are high-income economies with a very high Human Development Index (HDI) and are regarded as developed

countries.

The OECDs (Organisation for Economic Cooperation and Development) Corporate Governance Principles

First issued in 1999


Revised Principles issued in 2004 OECD Methodology for Assessing Implementation of the OECD Principles released in December 2006

Core Elements of the OECD Principles

I: Ensuring the basis for an effective corporate governance framework


The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities

II: Basic rights of shareholders and key ownership functions


The corporate governance framework should protect and facilitate the exercise of shareholders rights

III: Equitable treatment of shareholders


The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

The OECD Principles (continued)


IV: Role of stakeholders in corporate governance
The corporate governance framework should recognise the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

V: Disclosure and transparency


The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

VI: Board responsibilities


The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the boards accountability to the company and the shareholders.

ISSUES ON CORPORATE GOVERNANCE Structural issues Ethical issues

IMPORTANCE OF CORPORATE GOVERNANCE


Corporate governance is the system by which companies are directed and controlled. Good corporate governance is a key element in improving economic efficiency.

BENEFITS OF CORPORATE GOVERNANCE

Benefits of Corporate Governance


Good corporate governance ensures corporate success and economic growth. Strong corporate governance maintains investors confidence, as a result of which, company can raise capital efficiently and effectively. It lowers the capital cost. There is a positive impact on the share price. It provides proper inducement to the owners as well as managers to achieve objectives that are in interests of the shareholders and the organization. Good corporate governance also minimizes wastages, corruption, risks and mismanagement. It helps in brand formation and development. It ensures organization in managed in a manner that fits the best interests of all.

The obligations towards Companies


Compliance with the CG principles can benefit the owners and managers of companies and increase transparency and disclosure by: Improving access to capital and financial markets; Help to survive in an increasingly competitive environment through mergers, acquisitions, partnerships, and risk reduction through asset diversification; Provide an exit policy and ensure a smooth inter-generational transfer of wealth and divestment of family assets, as well as reducing the chance for conflicts of interest to arise.

The obligations towards Companies (Contd.)

Also, adopting good CG practices leads to a better system of internal control, thus leading to greater accountability and better profit margins.

Good CG practices can pave the way for possible future growth, diversification, or a sale, including the ability to attract equity investors nationally and from abroad as well as reduce the cost of loans/credit for corporations. Many businesses seeking new funds often find themselves obliged to undertake serious corporate governance reforms at a high cost and upon the demand of outsiders, often in a time of crisis. When the foundations are already in place investors and potential partners will have more confidence in investing in or expanding the companys operations.

The obligations towards Shareholders


Good CG can provide the proper incentives for the board and management to pursue objectives that are in the interest of the company and shareholders, as well as facilitate effective monitoring. Better CG can also provide Shareholders with greater security on their investment. Better CG also ensures that shareholders are sufficiently informed on decisions concerning fundamental issues like amendments of statutes or articles of incorporation, sale of assets, etc.

The obligations towards the National Economy


To standardise the productivity of the country To attract the instituitional investors to the country to improve the standard of living To increase the GDP To increase the FDI in all the sectors To ensure the optimum utilisation of resource to save non renewable resources

If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere. If a country opts for lax accounting and reporting standards, capital will flow elsewhere. All enterprises in that country suffer the consequences.

------ (Arthur Levitt, former chairman of the US Securities & Exchange Commission)

Theories Associated with the Development of Corporate Governance


There are 6 theories which affect the development of corporate governance: Agency Theory Transaction Cost theory Stakeholders Theory or Stewardship Theory Dependency theory Political theory Ethical theory